9 July 2012 | Volume 3 | Issue 16
The Blotter presents ITG’s insights on complex global market structure, technology, and policy issues.
Contributors Ofir Gefen Managing Director Ofir.Gefen@itg.com +85.2.2846.3573
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The land of the rising sun is pushing forward with market competition
On June 26, 2012 Japan’s financial markets regulator, the FSA, took another step to promote market competition by revising exemption from the 5% Takeover Bid (TOB) rule. This move may have a profound effect on Japan’s Propriety Trading System (PTS) providers over the coming months. This edition of The Blotter examines the history and development of PTSs in Japan and what this planned exemption may entail.
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To understand the context of this change, it is important to look at the history of market competition in Japan.
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Proprietary Trading Systems were introduced by the regulator in 1998 with the goal of promoting competition and innovation in the Japanese marketplace. However, it was not until recently that PTSs managed to draw any significant volume away from the Tokyo Stock Exchange (TSE) and other main exchanges. Only in recent months has the combined market share of the two main operating PTSs, SBI Japannext and Chi-X Japan, crossed the 7% by traded value of the Nikki225 (see chart on following page). This begs the questions: why has it taken so long and what has changed to allow for this growth?
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PTSs started as crossing systems and “after market” trading system in the beginning of the last decade. In more recent years, they have evolved to become a “full” daytime trading venue. In 2001, Instinet Japan started “INET” and “Japan Crossing” and Monex started “Monex Nighters”. Then in 2006, Kabu.com started “Kabu.com PTS”—first as an after hours market and later on as a day trading venue (Kabu since closed its operation). SBI Japannext started in 2006-07 as a consortium of a few banks (SBI Securities, Rakuten, Click, Orix, GS, CS and ML) initially to promote nighttime trading for its members and later in 2008 started a daytime market. Then in 2010, Chi-X Japan was backed by Chi-X Global and Nomura as a daytime venue,. In early 2010, the TSE had gone through a major technology upgrade known as Arrowhead. Arrowhead reduced access time and processing time to the exchange from a few seconds to milliseconds. With this upgrade, the minimum price variances (MPVs
THE BLOTTER | 9 July 2012 | Volume 3 | Issue 16
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or tick sizes) were revised and reduced overall spreads. This gave the TSE much needed firepower to combat the PTSs which were more technologically advanced, faster and also allowed for sub-Yen tick increments. The regulator then opened short selling on the PTS venues, a privilege previously kept by the major exchanges and denied to PTSs. With that ban lifted and with smaller tick sizes (and thus lower spreads), PTSs started to grow in popularity with hedge funds and statistical arbitrage operations. The larger traditional investors were initially concerned with counterparty risk but their concerns were resolved when regulation allowed the JSCC (Japan Security Central Clearing) to open its doors to PTSs in July of 2010, increasing confidence and, in turn, volumes. Still, one major concern existed for the larger institutional investors. The 5% Take-Over Bid rule (TOB rule) was designed to prevent investors from secretly executing large transactions off-exchange. In simple terms it states that when crossing a 5% holdings of the outstanding share amount of a company in an “off exchange” transaction, the investor shall go through a Tender Offer process. Exemptions were granted to the “OTC Securities Market” (i.e. JASDAQ) and in the case where the number of transaction counterparties in the last 60 days was less than ten. Since PTS transactions are considered off exchange any investor that bought shares on a PTS was at risk of triggering a Tender Offer process. As a result, many large professional investors chose to stay away from buying shares on PTSs. Enter the announcement from June 26. The proposed change offers to extend the exemption for the TOB rule if the following requirements are met: 1) the venue is a continuous matching venue 2) Prices are displayed in real-time 3) Venue ensures fair and equal access. The proposal is open for public response until July 26, 2012 and expected to take effect (if accepted) in October 2012. Effectively, this proposal will grant exemption from the TOB rule to PTSs and allow for the larger investors to fully participate in trading activities on these venues. Given their lower cost and lower spreads, the expectation is that trading volumes will therefore increase. How far? Well the next hurdle is a regulation that requires a PTS that has reached a 10% market share to register and become an exchange. The PTSs are looking to change that and the pending TSE-OSE merger may just provide them the leverage they need… Japan Market Share by Venue
Source: ITG, Inc.
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